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A position limit is a regulatory measure that sets a maximum size for an investment contract or option to prevent market instability and manipulation. The limit varies based on the investment and investor type, and is enforced by regulatory agencies like the CFTC. Violating the limit can result in fines or loss of investment privileges.
Sometimes referred to as a trading limit, a position limit is a specific level or position created by a regulatory agency and associated with a particular investment contract or option. The purpose of a position limit is to prevent an influx of options that could threaten the stability of a market and create widespread hardship for investors. Different options and futures contracts will carry a different position limit, based on the nature of the investment and the criteria set by the regulator.
In actual practice, a position limit serves to prevent any position associated with a given option from exceeding a maximum prohibited size. This helps minimize the potential for one investor or group of investors to corner a market and essentially undermine its stability. This does not mean that the position limit prevents anyone from earning a return on their investment. What this means is that a large trader does not gain an unfair advantage over smaller traders and is less likely to be able to engage in market manipulation that threatens to undermine the entire market.
The actual size allowed with the position will depend on a number of factors, including whether the entity holding the position is an individual investor, a group of investors or a corporation. The number of shares involved in the contract will also often play a role in determining the maximum limit of shares associated with the option that a given entity can hold. Various other criteria may also apply, depending on the details of a specific futures contract.
In the United States, the task of determining this maximum number in relation to futures contracts falls under the auspices of the Commodity Futures Trading Commission, or CFTC. Decisions are often made in conjunction with various exchanges that are based in the country. In other nations, it is not unusual for national regulatory agencies to also set a position limit independent of the criteria set by the exchanges based in those countries, even though the exchanges normally conform their standards to match those of the government regulator.
In situations where an investor holds multiple contracts for the same investment with different brokers, those contracts are usually treated as if they are all under one contract. This creates a situation where it is still possible to enforce the position limit fairly and minimize the possibility of one investor gaining an unfair advantage over others interested in that investment opportunity. Failure to comply with a position limit by taking steps to circumvent the checks and balances inherent in the system can lead to fines or possibly the loss of investment privileges with one or more exchanges.
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